Walmart, Home Depot — What you need to know for the week ahead

After their worst drop in two years, stocks bounced back with the Dow and the S&P 500 gaining all five days to gain more than 4% on the week.

The tech-heavy Nasdaq, which was the only losing among the major averages on Friday, paced gains for the week, rising 5%.

In the week ahead, a more quiet economic schedule faces investors after a run of inflation readings this past week pointed to higher prices coming to the U.S. economy. We’d also note that in the U.S. markets will be closed on Monday in observation of the President’s Day holiday, bringing investors a shortened week after what have been three-straight volatile weeks of market action after a placid 2017.

Fourth quarter earnings season is winding down, but a couple of premier reports are expected on Tuesday morning as both Walmart (WMT) and Home Depot (HD) will report results.

Walmart earnings on Tuesday morning will give investors a read on the U.S. consumer.

Through the market close on February 15, just under 90% of the S&P 500’s market cap had reported earnings and according to Credit Suisse, more companies are beating or meeting expectations than in any quarter in the last 20 years.

FactSet notes that 127 S&P 500 companies have so far raised earnings guidance for 2018, the most since the firm began tracking this data in 2007 and more than double the 10-year average of 49 members raising their outlook for the year ahead.

Last week, however, we reported that strong earnings do not necessarily coincide with strong returns, as earnings per share have increased in 70% of the 29 years since 1928 that the S&P 500 has finished the year with losses.

This week’s market recovery, however, may perhaps remind investors of what the bull thesis for 2018 was all along — strong earnings, strong economic growth, strong stock performance.

This past week, Wednesday’s data on consumer prices showed that inflation pressures appear to be building in the U.S. economy. The consumer price index rose 2.1% over last year in January, more than expected by economists. Excluding the cost of food and energy — which the Federal Reserve focuses more closely on — prices were up 1.8% in January, also more than expected. This data initially sent stock prices lower and bond yields higher.

Recall that last week’s stock market sell-off was initially seen by markets as having grown out of investor concerns about rising inflation, and thus more quickly rising interest rates. Producer prices and import prices were also shown to accelerate in January in reports out on Thursday and Friday, respectively.

But alongside Wednesday’s inflation data, retail sales for January were released. And they were ugly. Sales fell 0.3% in the first month of 2018 and December’s increase of 0.4% was revised down to show there was no growth compared to the prior month.

“The weaker tone of the January retail sales report, which showed a stagnation in underlying sales and downward revisions to previous months, suggests that real consumption growth is set to slow in the first quarter,” said Andrew Hunter, an economist at Capital Economics.

“If you think about it, the one thing that’s been a mantra of everyone, including myself for the past few weeks, is, ‘[The stock market sell-off] is all technical, it doesn’t matter, because the fundamentals are good’,” Tchir said. “Anything that puts a little bit of a question on the fundamentals, I think that tests us back to the lows.”

And indeed, reactions to Wednesday’s retail sales figures largely baked in that a rebound would follow and that this weakness does not indicate broader slowdowns in consumer spending given the favorable tax backdrop and solid economic growth.

“Before sounding the alarm, however, it is worth emphasising that the fundamentals remain supportive,” Hunter said Wednesday. “Jobs growth has been strong, consumer confidence is at a high level and the recent tax cuts will provide a one-off boost to disposable incomes this month.

“Accordingly, we wouldn’t be surprised to see retail spending pick up again over the next couple of months. And even if first quarter consumption growth is weaker than we had initially anticipated, this is unlikely to mark the start of a sustained downturn.”

“Stock market gyrations were dominated by rising incomes, employment growth, and by net favorable perceptions of the tax reforms,” said Richard Curtin, chief economist for the survey.

“When asked to identify any recent economic news they had heard, negative references to stock prices were spontaneously cited by just 6% of all consumers. In contrast, favorable references to government policies were cited by 35% in February, unchanged from January, and the highest level recorded in more than a half century.”

Tax cuts, then, are really the most important factor seeming to drive consumers. And, in turn, the economy.

The Financial Times’ Matt Klein has illustrated how U.S. recessions come about. And essentially, it all comes down to whether consumers are still willing to spend money on stuff — homes, cars, furniture, appliances. These are big ticket purchases that require both time to plan for and a confidence that the household’s economic picture won’t deteriorate in the years ahead.

This past week’s data, then, appears to be something of a mixed bag for the U.S. economic picture. On the one hand, spending from households to start 2018 appears soft and were this to begin a trend it would certainly muddy the economic outlook. On the other hand, consumer confidence appears undeterred by market gyrations and focused on the gains from tax cuts.

Both pieces of data can support positive or negative outlooks for the economy. One of them will be right.

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Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland